Productivity Increases, but Labor Costs Grow

The productivity of U.S. businesses rose at a swifter-than-expected pace in the second quarter, but labor costs still gained at their fastest rate in two years, a sign of building corporate cost pressures, new data show.

The Labor Department said Tuesday that productivity rose at a 2.9% annual rate in the second quarter, the smallest gain since the fourth quarter of 2002. However, it was strong enough to persuade economists that strides in business efficiency would still help restrain inflation.

Federal Reserve policymakers, who decided Tuesday to raise their benchmark short-term interest rate from 1.25% to 1.5%, cited “robust underlying growth in productivity” as a factor that continued to lend support to the economic expansion.

The nonfarm business productivity increase in the second quarter was a slowdown from the first quarter’s 3.7% advance, but well ahead of the 2% expected by Wall Street.

Growing productivity -- or worker output per hour -- tamps down inflation pressures by allowing companies to produce more without higher wage bills.

The April-June productivity slowdown contributed to a rise in the cost of labor per unit of production. Unit labor costs gained at a 1.9% annualized clip as hourly compensation, which includes wages and benefits, rose at a sharp 4.9% annualized rate.

Because labor represents the biggest single production expense for businesses, the rise in unit labor costs suggests worker compensation could begin eroding corporate profits unless firms can raise their selling prices.

An acceleration in price increases, in turn, would mean higher general inflation.

Still, the second-quarter rise in unit labor costs was just below the 2% increase forecast by private economists, on average.

What’s more, any sting from the latest rise in unit labor costs was tempered by a downward revision to the measure for the first quarter, which was lowered to a 0.3% annualized advance from the previously reported 0.8% gain.

Over the last year, unit labor costs have barely budged, edging up just 0.2%.

“The fact that unit labor costs remained well-contained suggests that the inflation outlook will remain benign,” said Merrill Lynch economist Ron Wexler.

Some economists said the productivity report showed businesses continued to find new efficiencies that allowed them to boost output while holding the line on hiring.

The government’s report Friday on July employment trends seemed to confirm that as well: The economy added a net 32,000 jobs last month, far below expectations -- even though other recent reports have shown that the U.S. manufacturing and services sectors expanded at a faster rate in July than in June.

Two other reports released Tuesday on retail chain store sales showed shopper traffic slowed last week, raising new concerns about consumer spending.

The International Council of Shopping Centers and brokerage UBS said in a joint report that sales grew 0.1% last week, slightly off from a 0.2% rise in the previous week. Sales were up 3.1% from year-ago levels.

A separate report from Redbook Research showed sales up 2.4% from a year ago, but off 0.5% so far this month when compared with July.